Within the electric power industry, Variable Cost can be defined as a power producing unit's instantaneous combined hourly cost for fuel and for emissions credits (buying or selling of). Marginal Variable Cost (MVC) can be defined as the change in Variable Cost that is caused by a small change in electric output for sale (export generation) under current or specified operating conditions. Thus, Marginal Variable Cost may be considered the slope of the curve showing variable cost vs. electrical output for current or specified operating conditions, evaluated at a power producing plant's current or specified electrical output.
The evaluation of Marginal Variable Cost (to create a Marginal Cost Curve (MCC)) can be treated as a steady state problem, wherein dynamic operating costs (such as increased NOx and fuel consumption while ramping), increases in depreciation charges (due to reduction in equipment lifetimes caused by thermal cycling of fast ramping), and contractual risk (the increased likelihood, due to ramping, that a forced outage would necessitate the purchase of replacement power) are ignored. Under this approximation, the cost of operating the power producing unit assumes that the unit is under steady state operation. However, it does not assume that the outside world is under steady state. In particular, there are factors external to the unit itself that can impact the unit's Marginal Variable Cost, such as the unit cost of coal or of NOx or SOx emissions. These factors, though dynamic, can be updated and factored into the evaluation of the Unit Marginal Variable Cost at a real time rate.
The marginal variable cost of a power plant (or unit within a plant) is a measure of the operational cost of producing a given increment to the power needed from the plant. One use of the MVC or the derived MCC is that it allows power producers to compare the cost of power production amongst their various facilities. This comparison is important because it enables a power producer to operate at a lowest cost to themselves and/or to their customers. For instance, when the power demand on a producer is anything other than their own full capacity, the producer can generate power starting with their lowest cost units and working up.
The MVC and MCC of individual power producers are also used by a variety of regulatory organizations within the power industry. The power industry can be broadly classified by three functions: power production, power transmission, and power distribution. The regulations, methods, and organizations that surround these functions have undergone a large amount of change in recent years in the U.S. Consequently, the manner in which the MVC and MCC are used is also undergoing change.
At present in the U.S., about 50% percent of the power that is produced is dispatched and transmitted via the use of an Independent System Operator (ISO) using Locational Marginal Pricing (LMP). LMP is a mechanism by which the ISO can ascribe reasonable and competitive sell and purchase prices for power producer and power distribution entities respectively. The LMP is defined as the sum of the MVC (or MCC), the Congestion Cost, and the Losses Cost. Power producers will bid to provide power for transmission based on the profit margin between their estimated actual LMP and the predicted actual LMP expected to be provided by the ISO. In the current marketplace, the MVC has a large variability and a significant impact on the LMP. MVC can range from about 15 to 100 $/MWh, Congestion Costs can range from about −20 to 150 $/MWh, and Losses Cost can range from about 3 to 8 $/MWh. A simple, accurate, reliable, and rapid mechanism for calculating the MVC or associated MCC is therefore desirable. The LMP method is gaining in popularity and is expected to be used for the pricing of about 75% of the power in the U.S. within the next year. The LMP method has been in practical operation for about 4 years in the U.S., even though the idea of the LMP as a method for pricing power is about 20 years old.
Prior to the advent of the LMP, power pricing was largely done using the Merit Order Dispatch (MOD) method. In MOD, each power producer supplies the MVC or MCC for each of their units to the regional Power Pool. The Power Pool organized each of the units according to the value of the MVC or MCC and then dispatched, or instructed each unit to produce a certain load, starting with the lowest cost producer and working up towards the more expensive producers, until the total required load was achieved. This method was more common in the U.S. when power distribution, transmission, and production were government regulated, integrated utilities provided all of the three functions described above within their franchise areas, and when the cost of the power was more directly passed to the consumer. The MOD method, however, is still in use in regulated areas of the U.S. and still benefits from accurate and reliable MCC or MVC evaluation.